Let The Sun Shine In On Public Pensions, Benefits

As debates heat up in states across the country over budget shortfalls, more and more focus is being placed upon the runaway growth in health and pension benefits for state and local government workers.

These excessive benefits are a major factor behind the exploding costs of government in many states. It is time to bring these costs under control before they completely overwhelm state and local budgets.

Setting aside partisan rhetoric, it is clear that the pension and health benefits actually being paid out to state and local workers and retirees have steadily grown more generous relative to those in the private sector. This has been happening for at least two decades because negotiations between governments and public sector unions lack transparency and accountability.

Taxpayers are rarely made aware of the costly promises that public-sector unions are able to extract from state and local governments. Politicians often find it easier to reward unions with deferred payments for pensions and health care instead of offering salary or wage increases that appear immediately on the budget.

Thus they are able to buy peace today by selling out the future. So far the unions have been happy to oblige them. Without fundamental reform, this pattern is bound to continue year by year with devastating consequences for public budgets, taxpayers' pocketbooks, and economic growth.

Consider these facts:

The pension benefits paid out to retirees by state and local governments have more than doubled from 11.1% of payroll in 1990 to 23.8% of payroll in 2009. By contrast, pension payouts in private industry grew only from 6.1% of payroll in 1990 to 9.8% in 2009.

The growth in state and local pension payouts relative to current payroll has been driven by steady increases in the generosity of pension agreements rather than by the aging of the state and local government workforce.

In 1993, retirement benefits paid out to state and local government retirees averaged $10,812 per year per beneficiary nationwide, or 35% of the $30,870 in wages and salaries paid out to the average full time employee. By 2008, average retirement benefits per public retiree had grown to $23,225, or 45% of the $52,058 in wages and salaries paid out to the average employee.

The growth in state and local pension payouts has continued year after year in good times and bad. In the wake of the dot-com crash that exposed pension funding problems everywhere, state and local governments nationwide added $1 trillion to the actuarial value of their pension promises.

From 2000 to 2006, the actuarial value of state and local pension commitments rose from $2.2 trillion (3.75 times payroll) to more than $3.2 trillion (4.2 times payroll). During the recent recession, many public agencies in California actually increased their commitments to retirees even as the state's financial condition deteriorated.

As recently reported by California's Little Hoover Commission, an independent state oversight agency, only 26 of the 1,500 plus public agency contracts with California's Public Employee Retirement Fund (CalPERS) were amended during 2008 and 2009 to lower benefits for new workers.

During the same period, nearly 200 agencies actually enhanced benefits for current workers in the face of the most sever fiscal crisis faced by the state since the Great Depression.

The same irresponsible pattern holds true for nonpension benefits. Among state and local governments across the nation, spending on nonpension benefits rose from 15.3% of payroll in 1990 to 21.9% of payroll in 2009, while over the same period spending on nonpension benefits in the private sector held steady at 16% of payroll.

The pattern is clear: pension and health benefits have grown much faster in the public than in the private sector and the pattern has continued in good times and bad regardless of obvious budget shortfalls.

The solution to the problem is to make the negotiating process more transparent and to apply to the public sector some of the approaches that have worked successfully in the private sector to control costs and to maintain the solvency of retirement programs.

California's SB400, a 1999 bill that retroactively increased public pensions, is a notorious example of how elected officials engage in pension giveaways when the fiscal consequences of these decisions are hidden and deferred to the future.

In evaluating the fiscal impact of that bill, actuaries at CalPERS maintained that legislators could pay for higher pensions out of excess earnings in the pension fund and that the state's contribution to the fund should remain below the level of 1999 contributions for at least a decade.

In fact, pension contributions from state and local governments in California rose more than three-fold from $4.8 billion in fiscal 1998-99 to $15.8 billion in fiscal 2007-08.

Until very recently, the accounting of the costs to taxpayers of health benefits for state and local government retirees has been even more opaque. Thus, taxpayers could not discern the costs of retiree health care benefits because most states lumped retiree health care costs with expenditures on health benefits for current workers on a pay-as-you go basis.

Now the Government Accounting Standards Board (GASB) has required state and local governments to provide an actuarial projection of the costs of promised retiree health benefits.

Based on these newly released estimates, the Government Accountability Office estimated in 2009 that state and local governments are carrying an unfunded liability for retiree health benefits of more than $530 billion, with $62 billion lodged against the state government in California. That figure is three-fourths as large as California's entire stock of long-term general obligation bonds but until recently it was not even recorded and even now it is not included in the state's balance sheet.

What is the solution? How can we make sure that public officials are carrying out their public trust? Here as in other situations sunshine is the best disinfectant.

First, we need real improvements in the accounting and reporting requirements for retiree pension and health benefits so that taxpayers, employees, public officials and bond investors have access to accurate information about the costs of these benefits that is consistent across time and comparable across governments.

Both the American Academy of Actuaries and the GASB have acknowledged the flaws in current accounting standards for public retirement systems. Both bodies are now engaged in efforts to design accounting frameworks that will provide all stakeholders with a clear understanding of the likely long term costs of retiree pension and health care benefits.

State and local governments should be held to uniform accounting and funding standards for the accrued liabilities to public employees similar to those imposed on private corporations by the Financial Accounting Standards Board and by federal ERISA regulations. This will allow stakeholders to monitor these liabilities as they are accrued.

These accounting reforms must have bite if they are to curb the temptation of public officials to award generous deferred benefits to public sector unions and the to skimp on the funding of these benefits as the annual bills come due.

The legislation would require state and local pension plans to submit accounting statements to the U.S. Treasury on a consistent and actuarially sound basis if these governments are to retain the privilege of issuing tax-exempt bonds. This legislation should become law.

Finally, with respect to new employees, state and local governments should no longer support retiree pension and health benefits as forms of deferred compensation. In the case of pensions, governments should adopt defined contribution plans like those now in use in the private sector in which the state and local liability is paid in full in cash when the employee's contribution is made.

The change to defined contribution plans has begun in 12 states in the past decade and should spread to all 50 states. There are otherwise too many conflicts of interest to rely on actuaries and accountants to hold elected officials and unions responsible for containing and funding these benefits.

These fairly simple steps will take us beyond the sound and fury of current debates to lasting solutions to an urgent fiscal challenge.

 Atkeson is the Stanley M. Zimmerman Professor of Economics at UCLA. Simon was the Republican nominee for governor of California in 2002 and is currently a visiting professor at the UCLA School of Law. Piereson is president of the William E. Simon Foundation and a senior fellow at the Manhattan Institute.

As debates heat up in states across the country over budget shortfalls, more and more focus is being placed upon the runaway growth in health and pension benefits for state and local government workers.

These excessive benefits are a major factor behind the exploding costs of government in many states. It is time to bring these costs under control before they completely overwhelm state and local budgets.

Setting aside partisan rhetoric, it is clear that the pension and health benefits actually being paid out to state and local workers and retirees have steadily grown more generous relative to those in the private sector. This has been happening for at least two decades because negotiations between governments and public sector unions lack transparency and accountability.

Taxpayers are rarely made aware of the costly promises that public-sector unions are able to extract from state and local governments. Politicians often find it easier to reward unions with deferred payments for pensions and health care instead of offering salary or wage increases that appear immediately on the budget.

Thus they are able to buy peace today by selling out the future. So far the unions have been happy to oblige them. Without fundamental reform, this pattern is bound to continue year by year with devastating consequences for public budgets, taxpayers' pocketbooks, and economic growth.

Consider these facts:

The pension benefits paid out to retirees by state and local governments have more than doubled from 11.1% of payroll in 1990 to 23.8% of payroll in 2009. By contrast, pension payouts in private industry grew only from 6.1% of payroll in 1990 to 9.8% in 2009.

The growth in state and local pension payouts relative to current payroll has been driven by steady increases in the generosity of pension agreements rather than by the aging of the state and local government workforce.

In 1993, retirement benefits paid out to state and local government retirees averaged $10,812 per year per beneficiary nationwide, or 35% of the $30,870 in wages and salaries paid out to the average full time employee. By 2008, average retirement benefits per public retiree had grown to $23,225, or 45% of the $52,058 in wages and salaries paid out to the average employee.

The growth in state and local pension payouts has continued year after year in good times and bad. In the wake of the dot-com crash that exposed pension funding problems everywhere, state and local governments nationwide added $1 trillion to the actuarial value of their pension promises.

From 2000 to 2006, the actuarial value of state and local pension commitments rose from $2.2 trillion (3.75 times payroll) to more than $3.2 trillion (4.2 times payroll). During the recent recession, many public agencies in California actually increased their commitments to retirees even as the state's financial condition deteriorated.

As recently reported by California's Little Hoover Commission, an independent state oversight agency, only 26 of the 1,500 plus public agency contracts with California's Public Employee Retirement Fund (CalPERS) were amended during 2008 and 2009 to lower benefits for new workers.

During the same period, nearly 200 agencies actually enhanced benefits for current workers in the face of the most sever fiscal crisis faced by the state since the Great Depression.

The same irresponsible pattern holds true for nonpension benefits. Among state and local governments across the nation, spending on nonpension benefits rose from 15.3% of payroll in 1990 to 21.9% of payroll in 2009, while over the same period spending on nonpension benefits in the private sector held steady at 16% of payroll.

The pattern is clear: pension and health benefits have grown much faster in the public than in the private sector and the pattern has continued in good times and bad regardless of obvious budget shortfalls.

The solution to the problem is to make the negotiating process more transparent and to apply to the public sector some of the approaches that have worked successfully in the private sector to control costs and to maintain the solvency of retirement programs.

California's SB400, a 1999 bill that retroactively increased public pensions, is a notorious example of how elected officials engage in pension giveaways when the fiscal consequences of these decisions are hidden and deferred to the future.

In evaluating the fiscal impact of that bill, actuaries at CalPERS maintained that legislators could pay for higher pensions out of excess earnings in the pension fund and that the state's contribution to the fund should remain below the level of 1999 contributions for at least a decade.

In fact, pension contributions from state and local governments in California rose more than three-fold from $4.8 billion in fiscal 1998-99 to $15.8 billion in fiscal 2007-08.

Until very recently, the accounting of the costs to taxpayers of health benefits for state and local government retirees has been even more opaque. Thus, taxpayers could not discern the costs of retiree health care benefits because most states lumped retiree health care costs with expenditures on health benefits for current workers on a pay-as-you go basis.

Now the Government Accounting Standards Board (GASB) has required state and local governments to provide an actuarial projection of the costs of promised retiree health benefits.

Based on these newly released estimates, the Government Accountability Office estimated in 2009 that state and local governments are carrying an unfunded liability for retiree health benefits of more than $530 billion, with $62 billion lodged against the state government in California. That figure is three-fourths as large as California's entire stock of long-term general obligation bonds but until recently it was not even recorded and even now it is not included in the state's balance sheet.

What is the solution? How can we make sure that public officials are carrying out their public trust? Here as in other situations sunshine is the best disinfectant.

First, we need real improvements in the accounting and reporting requirements for retiree pension and health benefits so that taxpayers, employees, public officials and bond investors have access to accurate information about the costs of these benefits that is consistent across time and comparable across governments.

Both the American Academy of Actuaries and the GASB have acknowledged the flaws in current accounting standards for public retirement systems. Both bodies are now engaged in efforts to design accounting frameworks that will provide all stakeholders with a clear understanding of the likely long term costs of retiree pension and health care benefits.

State and local governments should be held to uniform accounting and funding standards for the accrued liabilities to public employees similar to those imposed on private corporations by the Financial Accounting Standards Board and by federal ERISA regulations. This will allow stakeholders to monitor these liabilities as they are accrued.

These accounting reforms must have bite if they are to curb the temptation of public officials to award generous deferred benefits to public sector unions and the to skimp on the funding of these benefits as the annual bills come due.

The legislation would require state and local pension plans to submit accounting statements to the U.S. Treasury on a consistent and actuarially sound basis if these governments are to retain the privilege of issuing tax-exempt bonds. This legislation should become law.

Finally, with respect to new employees, state and local governments should no longer support retiree pension and health benefits as forms of deferred compensation. In the case of pensions, governments should adopt defined contribution plans like those now in use in the private sector in which the state and local liability is paid in full in cash when the employee's contribution is made.

The change to defined contribution plans has begun in 12 states in the past decade and should spread to all 50 states. There are otherwise too many conflicts of interest to rely on actuaries and accountants to hold elected officials and unions responsible for containing and funding these benefits.

These fairly simple steps will take us beyond the sound and fury of current debates to lasting solutions to an urgent fiscal challenge.

 Atkeson is the Stanley M. Zimmerman Professor of Economics at UCLA. Simon was the Republican nominee for governor of California in 2002 and is currently a visiting professor at the UCLA School of Law. Piereson is president of the William E. Simon Foundation and a senior fellow at the Manhattan Institute.

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